1 Simple Number To Help Investors Understand 3 Aspects Of City Developments Limited’s Business

City Developments Limited (SGX: C09) is one of the largest real estate companies in Singapore’s stock market. Right now, the company has total assets of S$19.9 billion and a market capitalisation of S$8.3 billion.

The company develops properties for sale and also invests in real estate in various sectors, such as commercial and hospitality.

In this article, I want to dig deep into the company’s return on equity, or ROE.

The choice of ROE

Why the ROE some of you might be asking? That’s because the financial metric gives investors important insight on a company’s ability to generate a profit using the shareholders’ capital it has.

A ROE of 20% means that a company generates $0.20 in profit for every dollar of shareholders’ capital invested. In general, the higher the ROE, the more profitable a company is.

That being said, it’s worth noting that the use of high leverage – which increases the financial risk faced by a company – can also increase a company’s ROE. So, that’s something to observe.

Calculating the ROE

The ROE can be calculated using the following formula, which is the way many investors do it:

ROE = Net Profit / Shareholder’s Equity

But, the ROE can also be calculated using a different approach shown below:

ROE = Asset Turnover x Net Profit Margin x Leverage Ratio

Doing so will reveal three important aspects about a company: How well it is managing its assets, how efficient it is at turning revenue into profit, and how much financial risk it could be taking on. For more information about this formula for the ROE, you can check out here.

So, let’s find out the ROE for City Developments.

The actual numbers

The asset turnover measures the efficiency of a company in using its assets to generate revenue. It is calculated by dividing a company’s total revenue by its assets. For City Developments, its asset turnover in 2015 is 0.163. It reported S$3.304 billion in revenue and S$20.32 billion in total assets.

The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In 2015, the net profit margin for City Developments was 26.2% (S$866 million in profit and S$3.304 billion in revenue).

Lastly, we have the leverage ratio, which shows the relationship of a company’s total assets to its shareholders’ equity. It is calculated by dividing total assets by shareholders’ equity. A higher ratio means that a company is funding its assets with more liabilities, hence resulting in higher risk. With total assets of S$20.32 billion and shareholders’ equity of S$11.21 billion in 2015, City Developments‘ gearing ratio is 1.81

When we put all the three numbers together for City Developments, we arrive at an ROE of 7.7%. This single-digit ROE is not very impressive. But, it’s in line with other large real estate companies in Singapore’s market. For instance,  CapitaLand Limited (SGX: C31) and Frasers Centrepoint Ltd (SGX: TQ5) had ROEs of 6% and 6.5%, respectively, in their last completed financial years.

If you like what you've seen, you can get even more investing insights and analyses from The Motley Fool's weekly investing newsletter Take Stock Singapore. It's FREE, so do check it out here.

Also, like us on Facebook to follow our latest news and articles. The Motley Fool's purpose is to help the world invest, better.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Lawrence Nga doesn’t own shares in any companies mentioned.